CoinBase acquires Custody business of Xapo

Cryptocurrency firm Coinbase has acquired the custody business of Xapo, a service best known for storing Bitcoins in a vault under a Swiss mountain. The acquisition comes as part of an aggressive push by Coinbase to expand its custody services, and could result in the San Francisco company storing over 5% of all Bitcoins in circulation.

Coinbase paid $55 million for Xapo and, as a result of the deal, now has over $7 billion in crypto assets under management, according to a person familiar with the deal. The person, who was not authorized to speak for attribution, said the purchase came after Coinbase outbid investment giant Fidelity.

Xapo, which launched in 2013, will hold onto its exchange business, which lets ordinary consumers buy and sell Bitcoin. Its founder, Wences Casares, says he will stay on in his long-time role of CEO.

In an interview with Fortune, Casares said the retail exchange business has always been Xapo’s core focus, and that the custody business developed as a sideline at a time when wealthy Bitcoin investors needed a secure place to park their digital wealth.

“It’s hard to do a consumer business well at the same time as an institutional business. Earlier this year, we looked for a home for it,” he said, Casares said other firms placed higher bids for Xapo’s custody business than the one from Coinbase, but those bidders lacked the security or regulatory credentials to be acceptable to Xapo’s clients.

Among those clients was Grayscale Investments, which manages Bitcoin and other crypto investments in trust for wealthy customers. In early August, Grayscale transferred over 225,000 Bitcoins worth about $2.7 billion in assets to Coinbase Custody, one of the largest crypto transactions in history.

According to Casares, Xapo will keep possession of the vault and use it to store Bitcoins on behalf of its retail customers. Meanwhile, Coinbase has elaborate security measures of its own, including systems to store private keys—which unlock Bitcoin wallets—in secret locations in various cities.

Casares, a serial entrepreneur who is famous in crypto circles as an early Bitcoin evangelist, says the bulk of Xapo’s retail business takes place in South America and other developing countries. A native of Argentina, Casares has often spoken of how Bitcoin can help ordinary people hedge against the monetary predations of corrupt and incompetent governments.

For Coinbase, the acquisition of Xapo’s custody business escalates its efforts to expand beyond its core trading business. For years, profits from trading commissions have been the company’s bread and butter, but, while lucrative, the business is exposed to the crypto industry’s notorious volatility.

Custody could be the answer to that. Coinbase is betting that building a secure storage system that meets regulatory requirements will lure investors that have till now been wary of adding crypto to their portfolios.

According to CEO Brian Armstrong, the company on average is adding 10 new custody customers a week and $200 million in new assets. Following the Xapo acquisition, Coinbase says it now has over 150 clients for its custody business.

”Custody is a critical step toward the institutionalization of crypto economy. It’s likely to start off small—maybe a few billion under custody—but it will grow quickly to a point that it’s a meaningful piece of stable, recurring revenue for the company,” said Armstrong.

While custody promises a dedicated revenue stream, it’s unclear if the traditional arrangement—where customers pay a small fee for secure storage—is viable. At a time when some U.S. dollar savings accounts are paying over 2% interest, and startups like Compound are offering ways to lend crypto to earn income, Bitcoin customers may balk at earning a negative return.

According to Coinbase Custody CEO Sam McIngvale, the safety deposit box model of custody is rapidly changing. “Moving forward, the next phase of crypto custody is a much broader suit of services serving a much broader set of crypto assets,” he said, noting that Coinbase is working to store dozens of digital currencies, while Xapo has only provided custody for Bitcoin.

Coinbase’s new custody services will include insurance and regulatory support, as well as “staking,” which amounts to a sort of proxy voting service for cryptocurrencies that have built-in voting mechanisms. “Fundamentally, we have to help our investors earn a return on their assets. You can imagine lending out Bitcoin and earning interest on that,” McIngvale said.